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A good point. Conversely, central banks and governments fight recessions with expansionary monetary policy. Thus, as a recession hits government may reduce the

A good point. Conversely, central banks and governments fight recessions with expansionary monetary policy. Thus, as a recession hits government may reduce the cost of capital to VCs, and improve R+D (at least in defense spending and government research).

aaavl2821 9y ago
That could happen, but it is likely there will be a significant contraction in VC funding at least initially in the event of a recession. Firstly, the very low interests rates in the US and worldwide the last decade provide very limited room for governments to reduce cost of capital. Current fed funds rate is 1.42% after being essentially 0% since 2009. In 2007, the rate was 5.25%. In 2000 before the dot com crash, fed funds rate was 6.51% (dropped to nadir of 1% by 2004). [1] Unless interest rates rise dramatically before the next recession, the US govt will have the least monetary policy ammunition ever to respond to a recession. So there may not be that much reduction in cost of capital. Perhaps more importantly, any further fiscal tightening in advance of a recession could be very destructive to venture capital. One of the reasons VCs have so much cash now is that investors are chasing yield -- with govt debt at all time low rates (meaning high prices), and negative interest rates for some major governments, and with the stock market in one of its largest bull markets ever, investors have been investing into ever riskier asset classes. the laws of finance state than when interest rates go up, bond prices fall, and stock prices fall as well [2, 3]. yield will become cheaper (ie you can get higher return for lower risk: imagine getting 5% from a government bond today, and an expected return of 8-10% for large cap stocks: no one would invest in super risky VC in hopes of maybe 12-15% returns). with attractive returns available for lower risk, investors will cycle away from investments like VC and towards large cap stocks and bonds that's the theory, and in reality you observe a contraction in VC after recessions (post 2000s, post financial crisis). then capital leaves the VC space, so deals are less competitive and prices are lower, and the VCs that stick around make lots of money, then other people try to get in on the VC returns, prices go up again, returns go down, and the cycle goes on [1] https://fred.stlouisfed.org/series/FEDFUNDS https://fred.stlouisfed.org/series/FEDFUNDS [2] https://www.investopedia.com/investing/how-interest-rates-affect-stock-market/ https://www.investopedia.com/investing/how-interest-rates-af... [3] https://www.investopedia.com/terms/c/capm.asp https://www.investopedia.com/terms/c/capm.asp

aaavl2821 9y ago

That could happen, but it is likely there will be a significant contraction in VC funding at least initially in the event of a recession. Firstly, the very low interests rates in the US and worldwide the last decade provide very limited room for governments to reduce cost of capital. Current fed funds rate is 1.42% after being essentially 0% since 2009. In 2007, the rate was 5.25%. In 2000 before the dot com crash, fed funds rate was 6.51% (dropped to nadir of 1% by 2004). [1] Unless interest rates rise dramatically before the next recession, the US govt will have the least monetary policy ammunition ever to respond to a recession. So there may not be that much reduction in cost of capital. Perhaps more importantly, any further fiscal tightening in advance of a recession could be very destructive to venture capital. One of the reasons VCs have so much cash now is that investors are chasing yield -- with govt debt at all time low rates (meaning high prices), and negative interest rates for some major governments, and with the stock market in one of its largest bull markets ever, investors have been investing into ever riskier asset classes. the laws of finance state than when interest rates go up, bond prices fall, and stock prices fall as well [2, 3]. yield will become cheaper (ie you can get higher return for lower risk: imagine getting 5% from a government bond today, and an expected return of 8-10% for large cap stocks: no one would invest in super risky VC in hopes of maybe 12-15% returns). with attractive returns available for lower risk, investors will cycle away from investments like VC and towards large cap stocks and bonds that's the theory, and in reality you observe a contraction in VC after recessions (post 2000s, post financial crisis). then capital leaves the VC space, so deals are less competitive and prices are lower, and the VCs that stick around make lots of money, then other people try to get in on the VC returns, prices go up again, returns go down, and the cycle goes on [1] https://fred.stlouisfed.org/series/FEDFUNDS https://fred.stlouisfed.org/series/FEDFUNDS [2] https://www.investopedia.com/investing/how-interest-rates-affect-stock-market/ https://www.investopedia.com/investing/how-interest-rates-af... [3] https://www.investopedia.com/terms/c/capm.asp https://www.investopedia.com/terms/c/capm.asp